Virtual Currency

What Every Business Leader Should Know about Bitcoins

By Brad Jacobsen

July 31, 2014

Given the globalization of economies and the ease of transferring value via virtual currencies, Bitcoins (as well as other virtual currencies) are far from a passing fad and are only going to become more ingrained in our everyday lives. The simple fact that laws and regulations for Bitcoin are being enacted across the globe demonstrates the validity and impact of virtual currencies.

Below are a few FAQs that will help you understand some of the basics of Bitcoins and other virtual currencies.

What is a Bitcoin?

The easiest way to view Bitcoins is to picture them as a commodity, such as gold. Bitcoins are intrinsically valued based on supply and demand. They are valued at the price someone will pay in order for someone else to sell.

A Bitcoin, however, is a virtual asset (not tangible), consisting of a numerical entry on a public ledger known as a Blockchain, and is owned by the possessor of a secret number, or “private key.” The private key has a mathematical relationship with the public number in the ledger entry.

The Bitcoin Network is a system that creates and tracks the transfer of ownership of each Bitcoin and acts as a distributed ledger combined with a timestamp server, creating a single unretractable public record of all transactions in chronological order, thus ensuring correct current ownership. The Bitcoin Network is not operated by any single organization,
but rather is a decentralized system consisting of all the users of the Bitcoin software worldwide.

Are there other Virtual Currencies?

As Bitcoins have gained in popularity, the number of other virtual currencies available has increased significantly. In fact, there are currently more virtual currencies then there are “real” currencies in the world. Time will tell how many of these virtual currencies will survive.

Are Bitcoins and other Virtual Currencies Regulated?

This depends on a person’s role in utilizing the Bitcoins. Ordinary users are not regulated as a money service business (MSB) through the Department of the Treasury Financial Crimes Enforcement Network (FinCEN).

However, FinCEN declared that a user of virtual currencies that is deemed to be an “administrator or exchanger is an MSB under FinCEN’s regulations, specifically, a money transmitter” and will be required to comply with the reporting and recordkeeping regulations of the BSA pursuant to FinCEN’s regulations. These rules essentially require a person who exchanges or transmits Bitcoins or other virtual currencies from one medium to another, like paying cash for Bitcoins or providing Bitcoins for cash, to report any such transactions to FinCEN in excess of $10,000. Additional record keeping and reporting requirements apply as well.

More complicated compliance issues arise at the state level. States like Virginia, Texas, New York and California have issued subpoenas to Bitcoin businesses and/or threatened jail time for their failure to properly license in each applicable state as an MSB/money transmitter. Not all states require licensure. Utah, for example, does not currently require registration for a money transmitter in virtual currencies, but many states are looking into this area and will likely follow FinCEN’s lead.

How are Bitcoins Taxed?

According to the latest IRS guidance, virtual currencies such as Bitcoins will be treated as property for federal tax purposes. Because of this, gains from buying and selling Bitcoins will be treated like any other capital gains. Bitcoins held for more than one year qualify for long-term capital gains. Bitcoins held for less than one year are treated as ordinary income.

People who receive Bitcoins as compensation for services should treat the receipt of Bitcoins as income, and the Bitcoins should be valued at the market price in U.S. dollars at the time a payment is received. For those who have acquired Bitcoins and use them to purchase assets or services, the IRS treats such purchase as a taxable event. For instance, if the purchaser acquired a particular Bitcoin for $5 and then purchased goods or services with that Bitcoin when the value was $500, the person would need to declare $495 in capital gains. Losses would be treated in a similar fashion.

Are Bitcoins Affiliated with Illicit Activities?

While Bitcoins have always been used for many purposes, good and bad, early on Bitcoin trading was associated with money laundering, purchase of illegal goods and services, and other nefarious purposes. Many people still think of the governmental raid and shut down of Silk Road, a website that used Bitcoins to trade illegal drugs and other items, as the typical Bitcoin site.

Bitcoins have now gone mainstream and are being used by numerous companies such as Overstock.com, WordPress.com, Tesla, Tigerdirect and Bloomberg.com. Regulations imposed by governments have, in a sense, legitimized Bitcoins and made their use more appealing.

Brad Jacobsen is a partner at Michael Best & Friedrich LLP, specializing in corporate, securities, real estate and mergers and acquisitions. Fred Peña is an associate in the firm’s transactional practice group. Editor’s Note: This article originally appeared in the Utah Bar Journal and is a condensed and edited reprint.